Soft landing for real estate

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While property prices are predicted to drop, or plateau, at least rents look set to rise, writes David Potts.

As if to make up the drop in auctions, we've found the new game of reverse bidding. So let's play "how far property prices will drop".

Property analyst John Wakefield weighed in last week with a 10 to 15 per cent drop by the end of the year.

"The poor volume and clearance results will continue to translate into price declines throughout the second half of 2004," he said. "By the end of this year, I expect prices to be down 10 to 15 per cent from current levels."

A good opener, but economist Shane Oliver of AMP Capital Markets did better. He's predicting a 30 to 40 per cent slump. But hang on, that was city high-rise units.

For your quarter-acre block in the 'burbs, it's a more sedate drop of 5 to 10 per cent.

Well we can all live with that, only there's a sting in the tail. He also predicts a "long period of nothing" of at least five and possibly 10 years when property prices go sideways. Just like 1989 to 1995, when prices went nowhere.

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Even London's The Economist newspaper is playing. Big time. It's predicting a 20 per cent drop across the board, based on what is needed to get property prices back to the same average proportion of earnings as they were between 1975 and 2003.

At least the good news is that it says this can happen as much with a rise in wages and rents as a straight-out home price drop. That the normally Euro-centric Economist even bothered to look at Australia was substantial in itself, although there's no explaining New Zealand. The reason is that just about every Western nation has gone through an unprecedented property boom. So it makes sense that if we're all in this together, a crack in one place is going to show up in the others.

The story so far

There's just one snag. It's debatable just how far property prices have already dropped, and even whether they really have. And not every property guru thinks prices will fall anyway. With the exception of city high-rises.

Residex's John Edwards predicts interest rates will rise by 0.5 per cent at the most sometime next year, which "is not enough for a bust". The worst he can see is that some suburbs in Sydney and Melbourne "might correct". He says it's "hard to justify a fall because of immigration pressure".

Although it seems pretty clear that house and unit prices dropped in the March quarter, and probably in the June quarter as well, it may not be as bad as it looks.

In fact, research by CommSec suggests that in Sydney and Melbourne, property prices are still rising. Don't ask me which street, but it does have a compelling case. You see the problem is that not only do prices bounce around from quarter to quarter, but we're not comparing apples with apples.

"Different houses in different quarters will give different median prices," said CommSec's head of quantitative research, Ron Bewley.

Just imagine, heaven forbid, if property were like the sharemarket, so every house is auctioned every minute. The result would be all over the place. You'd have spectacular drops and rises that would mean nothing.

As it is, the December quarter was a boomer, so it's virtually meaningless to say that prices since then have dropped. They would, wouldn't they?

But compared with the same period a year ago, prices are still rising, which is what CommSec discovered.

And if, as seems likely, prices in the June quarter were higher than the March quarter but lower than the December quarter, what does that mean?

It's like the glass that's half filled. Or half empty.

Frankly, unless there's blood on the streets, so to speak, property will do all right. Although the clearance rate has dropped at auctions from more than 70 per cent a year ago to just 44 per cent last week, there's more to this than meets the eye. For one thing, the rate had dropped as low as 32 per cent one week in May. When you look at auction clearance rates, you could validly argue that the market's improving.

I wouldn't though. It's more likely that vendors can see that auctions aren't the way to go in what is, even on the most optimistic slant, a stagnant market. So the recovery in clearance rates probably has more to do with vendors shifting to private-treaty (that is, "for sale") sales rather than any improvement. With fewer properties being auctioned - even if more are being offered by private treaty - you'd expect the proportion being sold to rise. But remember, fewer auctions don't necessarily mean fewer properties.

CommSec's prediction is that property price increases will slow to a crawl, settling in a plateau that could last anything from four to eight years. "House prices won't collapse. I do expect them to slow but we won't have sustained negative growth," said quantitative analyst Nikola Dvornak.

Interest rates

Wherever the property market is now, the obvious threat is where interest rates are going.

Because of today's much larger mortgages, Mark Bouris of home lender Wizard says the equivalent of the late-1980s' 17 per cent interest rates is about 8 per cent. That's only 1 per cent away, or four lots of 0.25 per cent rises. The most economists expect this year is another 0.25 per cent. And that would have more to do with global rates rising than anything nasty happening here.

But there is a snag. Rates in the US need to rise from 1.25 per cent to the more normal level of 4 per cent. If my maths are right, and I'm not making any claims here, that's 11 rate rises which, even if spread over 18 months, would mean one every two months.

So while a 4 per cent cash rate is hardly penal - ours is 5.25 per cent - the problem is getting there. Eleven rises would sap anybody's confidence, especially as, each time, there's bound to be debilitating speculation about whether the Reserve Bank will follow suit.

The economy

The only threat that is even bigger than a rate rise is a slump in the economy. Job losses would force many investors and home owners to default on mortgage repayments.

Just as it wouldn't take much of a rise in rates to reach the financial trigger of the late-1980s, nor would it take much of a deterioration in the job market. For the same reason - the level of debt.

Fortunately, job losses are less likely than rate rises. The economy is doing nicely, thank you.

Property slumps are caused by unwilling sellers, not poor owners, so while there are no forced sales by the banks, we're safe on that score.

The other category of unwilling sellers is developers who go belly-up. "There are a couple of smaller developers in Sydney going down the gurgler," Edwards warns.

Then there's the booming sharemarket. It's attracting the punters away from property into shares. Little wonder. The annual rent return after costs on a Sydney or Melbourne property is barely 3 per cent. With no prospect of capital gain in sight, and if the pundits are right, the potential of a short-term loss, property doesn't stack up against the average dividend yield of 4 per cent and double-digit profit growth.

Nor is it a good sign that Robert Mellor, property guru for economic forecaster BIS Shrapnel, thinks the sharemarket has better prospects. "I've been saying that for six months," he said.

One consolation is he can see the rental returns from property increasing, a voice of hope amid the gloom and doom.The vacancy rate, still high, has fallen from 4.5 per cent a year ago to 3.5 per cent.

And most would-be first-home buyers who can't afford these high prices will need digs, which pushes up rents.

Never underestimate the impact of immigration either. While the population is increasing, there's a natural floor to property prices.